Get With The Plan: March 14, 2010

Harvey, 75, and Nadine, 71, share the same concerns as most retirees. They want to make sure they don’t run out of money, but they’re not sure how their investments should play in their plan.

“Our main concern is where our assets should be invested,” says Harvey. “Presently 77 percent of our assets are invested in mutual funds. Should distribution of our assets be monthly, yearly, or as needed?”

The Mercer County couple, whose names have been changed, have set aside $80,728 in IRAs, $2,768 in a brokerage account, $2,850 in savings and $2,920 in checking.

The Star-Ledger asked Michael Maye, a certified financial planner and certified public accountant with MJM Financial Advisors in Berkeley Heights, to look at Harvey and Nadine’s financial situation to see what they can do better.

“The couple’s current spending exceeds their retirement income, excluding IRA Required Minimum Distributions, by roughly $2,400 per year,” Maye says. “This gap will continue to widen over time as their retiree income will not keep pace with inflation over time as their pensions are not inflation-adjusted.”

That will present a challenge for Harvey and Nadine over time as prices for goods in general will rise.

The couple’s main goal should be to maintain their standard of living and not outlive their assets. They say overall, they’re in good health, and living into their 90s is absolutely a possibility. That means they have some choices to make.

The first option is to reduce spending now, Maye says. If they cut their spending by roughly $5,600 per year, they will create a more sustainable standard of living over the next 20-plus years, based on his projections.

That means they should take a close look at their budget to see if there are places to cut. Of course, they need to enjoy life, too, so they need to prioritize their spending and decide which items are most important. One place to look is credit card spending.

“The credit card debt is the first sign of a cash flow shortfall being made up via credit card use,” Maye says. “This can be a dangerous way to fund cash flow shortfalls because over time the hole will get bigger as the interest compounds.”

This needs to be part of cutting their expenses so they do not have a cash flow shortfall, he says.

So they should try to pay down their credit card debt, which would free up more money so they can build up their cash reserves, or emergency fund, which isn’t big enough. They have a cushion of about one-and-a-half month’s worth of expenses, but they should try to double that, Maye says.

The couple’s other large discretionary spending is travel, hobbies and entertainment.

“Perhaps they can figure out a way to modify these items based on what is most important to them,” Maye says.

Harvey and Nadine might be tempted to tap their IRAs for extra cash, but Maye says taking more than the Required Minimum Distribution could result in a higher tax bill, so they should run the numbers before making that kind of move.

If they don’t adjust their spending now, they have to accept that they’ll maintain their current standard of living until they exhaust their investment assets. At that point, they’ll be limited to their retirement income, which will result in a lower standard of living, Maye says.

By then, Harvey and Nadine may consider taking cash value from their life insurance policies, or even a reverse mortgage, to fund the later years of their retirement. The proceeds of a reverse mortgage could be used for maintaining their home, to pay for out-of-pocket medical services or supplement their income in order to maintain their lifestyle.

“The consequences are the high upfront costs and, when the house is sold in the future, any outstanding balance on the reverse mortgage will need to be repaid first,” Maye says. “Obtaining a reverse mortgage is not to be done lightly, and individuals must attend counseling sessions before obtaining one.”

Next, asset allocation. The couple’s portfolio looks more like that of a young couple, or a couple with a very high risk tolerance, with 75 percent invested in equities.

“This is extremely aggressive given their ages, coupled with the fact they describe themselves as conservative investors,” Maye says. “The portfolio they are holding could be expected to lose 25 to 30 percent during a downturn such as 2008.”